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Why Play in the U.S. Stock Market?

Success in the U.S. Stock Market has always been based on knowing more than the general public does about market direction and the industry, company and corporate leadership of those stocks you invest in. So, why would you play in the market when you know the game is rigged?

The Security and Exchange Commission (S.E.C.) has brought numerous cases, part of a campaign to root out insider trading and, in theory, make markets fairer for the average investor. In recent weeks alone, the S.E.C. filed complaints against traders who ran the gamut from celebrity to ordinary.

No one knows how much cheating of this kind occurs, but regulators have developed good tools for spotting it. Every time there is market-moving news, like a merger or an earnings report, computers at Finra, a regulatory body, scan millions of buy and sell orders, looking for suspicious trades, like a big stock purchase in advance of a takeover. Finra refers some 250 trades a year to the S.E.C. for a closer look. Getting a stock-market tip has always been a sort of all-American fantasy, and despite the risk of detection, the desire for an edge seems irresistible. “People are greedy,” says Robert Khuzami, the S.E.C.’s director of enforcement. “They think they won’t get caught.”

The law on insider trading, which has developed over the years from judicial rulings and is not specifically found in a statute, is ambiguous enough to allow for a range of interpretations. And at a time when the government is accused of going easy on white-collar crime, Khuzami has pursued an aggressive approach, pushing the boundary of what is deemed illegal. Strengthening the S.E.C.’s long-running effort, Khuzami has focused, particularly, on the hedge fund industry, which for reasons related to its competitiveness, capital and connections, he sees as especially prone to insider trading. Perhaps more important, the bread-and-butter civil actions brought by the S.E.C. is putting pressure on traders to refrain from using information that is even borderline illegal.

To an unusual degree, respect for insider trading laws depends on the visibility of enforcement. In a survey of 2,500 traders taken in 2007, more than half said they would take advantage of an illegal tip if they were assured they wouldn’t be caught.

The courts have established that it is illegal to trade on “material” information in breach of a duty to keep the information private. The legal ambiguity arises on two fronts. First, the standard for “material”— any news that a trader would consider important — is fuzzy enough to recall Potter Stewart’s famously elusive definition (he would know it when he saw it) of pornography. Rumors and gossip circulate in the stock market every day; not all of it is “material.” Second, the question of who has a duty to keep the material information private is not always clear.

Especially in volatile markets, the temptation to cheat is fierce. When stocks jump or plummet in reaction to news, the payoff for those who trade on tips ahead of the news rises as well. Ferreting out who is prescient and who is crooked becomes more important than ever.

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Why Play in the U.S. Stock Market?

Success in the U.S. Stock Market has always been based on knowing more than the general public does about market direction and the industry, company and corporate leadership of those stocks you invest in. So, why would you play in the market when you know the game is rigged?

The Security and Exchange Commission (S.E.C.) has brought numerous cases, part of a campaign to root out insider trading and, in theory, make markets fairer for the average investor. In recent weeks alone, the S.E.C. filed complaints against traders who ran the gamut from celebrity to ordinary.

No one knows how much cheating of this kind occurs, but regulators have developed good tools for spotting it. Every time there is market-moving news, like a merger or an earnings report, computers at Finra, a regulatory body, scan millions of buy and sell orders, looking for suspicious trades, like a big stock purchase in advance of a takeover. Finra refers some 250 trades a year to the S.E.C. for a closer look. Getting a stock-market tip has always been a sort of all-American fantasy, and despite the risk of detection, the desire for an edge seems irresistible. “People are greedy,” says Robert Khuzami, the S.E.C.’s director of enforcement. “They think they won’t get caught.”

The law on insider trading, which has developed over the years from judicial rulings and is not specifically found in a statute, is ambiguous enough to allow for a range of interpretations. And at a time when the government is accused of going easy on white-collar crime, Khuzami has pursued an aggressive approach, pushing the boundary of what is deemed illegal. Strengthening the S.E.C.’s long-running effort, Khuzami has focused, particularly, on the hedge fund industry, which for reasons related to its competitiveness, capital and connections, he sees as especially prone to insider trading. Perhaps more important, the bread-and-butter civil actions brought by the S.E.C. is putting pressure on traders to refrain from using information that is even borderline illegal.

To an unusual degree, respect for insider trading laws depends on the visibility of enforcement. In a survey of 2,500 traders taken in 2007, more than half said they would take advantage of an illegal tip if they were assured they wouldn’t be caught.

The courts have established that it is illegal to trade on “material” information in breach of a duty to keep the information private. The legal ambiguity arises on two fronts. First, the standard for “material”— any news that a trader would consider important — is fuzzy enough to recall Potter Stewart’s famously elusive definition (he would know it when he saw it) of pornography. Rumors and gossip circulate in the stock market every day; not all of it is “material.” Second, the question of who has a duty to keep the material information private is not always clear.

Especially in volatile markets, the temptation to cheat is fierce. When stocks jump or plummet in reaction to news, the payoff for those who trade on tips ahead of the news rises as well. Ferreting out who is prescient and who is crooked becomes more important than ever.